Why ten year Treasury yields are at 52-week highs and how it affects MLPs

Last week, the yield on the ten year U.S. Treasury increased by 4 bps from 2.13% to 2.17%. Yields increased as the market speculated that the Federal Reserve could soon scale back or end its current bond buying program, which pumps money into the financial system and keeps interest rates low.

The yield on the ten year U.S. Treasury has increased significantly, from 1.63% in early May to approximately 2.20% currently, and is at its highest point in over a year.

Treasury yields matter because MLPs can be rate-sensitive instruments, and an increase in Treasury yields could push investors to require more yield out of riskier investments such as MLPs.

Investors who hold master limited partnership (MLP) stocks often monitor interest rates on Treasury bonds. This is because many investors hold MLP stocks for the distribution, or “yield,” component of the securities. U.S. government Treasury yields are relevant because if rates on the bonds increase, investors should expect rates on MLPs to theoretically increase as well. This is due to the fact that many view U.S. Treasuries as one of the safest yielding investments in the financial universe, and if the rates on Treasuries increase, the yield required from MLPs (and all other yield instruments) should also theoretically increase. When the yield on MLPs increases, the price and valuation of MLPs decrease.

Additionally, when yields on instruments such as Treasuries decrease, it also pushes investors seeking current income into other instruments, such as corporate bonds and MLPs. Therefore, as Treasury yields decrease, yields across the bond sector and higher dividend stocks, such as MLPs, also tend to decrease.

The yield on the benchmark ten year Treasury continued to increase last week as it rose from 2.13% to 2.17% for the week ended June 7th. The yield on the ten year Treasury has been consistently on the rise since early May when it was trading at around 1.65%, compared to current levels of ~2.20%. The rate on the ten year Treasury is the highest it has been in over 52 weeks.

This marks the fourth week in a row that the yield on the ten year Treasury has increased. Yields had generally compressed since mid-March when the ten year was trading around ~2% to lows of 1.65% in late May until increasing at a relatively quick pace to current levels of ~2.20%.

In the context of a longer time period, Treasury yields had been close to all-time lows for awhile, though recently yields have backed up. The below graph shows historic yields on the ten year Treasury from the beginning of 2001 to present.

The low yields over the past few years have mostly a consequence of the Federal Reserve pumping money and liquidity into the financial system. The below graph shows the yields on the Alerian MLP Index versus ten year Treasury yields.

Except for the period of the financial crisis, where investors pulled money out of riskier investments such as equities (which MLPs are) and poured it into cash and Treasuries, MLP yields have often moved directionally the same as Treasury yields.

Over the past several weeks, the yields on Treasury instruments have increased, resulting in a negative medium-term catalyst for the rate-sensitive MLP sector. However, from a longer-term perspective rates remain relatively low which has resulted in a long-term positive for MLPs. If rates eventually rise, for example, to pre-recession levels of 4-5%, it could be a negative for MLPs and the Alerian MLP Index (AMLP). Major names in the index include Enterprise Products Partners (EPD), Kinder Morgan Energy Partners (KMP), Magellan Midstream Partners (MMP), and Plains All American Pipeline (PAA). Therefore, owners of MLPs should be aware of rate movements and how they affect MLPs.

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